Bankruptcy and the Market for Mortgage and Home Improvement Loans

Abstract

This paper investigates the relationship between bankruptcy exemptions and the availability of credit for mortgage and home improvement loans. We develop a combined model of debtors' decisions to file for bankruptcy and to default on their mortgages and show that the theory predicts positive relationships between both the homestead and personal property exemption levels and the probability of borrowers being denied mortgage (secured) and home improvement loans. We test these predictions empirically and find strong and statistically significant support when evidence from cross-state variation in bankruptcy exemption levels is used. Applicants for mortgages are 2 percentage points more likely to be turned down for mortgages and 5 percentage points more likely to be turned down for home improvement loans if they live in states with unlimited rather than low homestead exemptions. These relationships also hold when we introduce state fixed effects into the model.